Effect of Foreign Exchange Rates Volatility on Financial Performance of Agricultural Sector in Kenya

Abstract

The effect of how volatile exchange rates are and how this affects ability of firms to perform financially has been a subject of discussion among policy makers and scholars around the world. Most agricultural firms rely on exports to generate revenues that finance their operations. However, there has been volatility in exchange rates in Kenya as explained by political instability and the changes in other macro-economic variables including inflation and interest rate which has affected the agricultural sector. As such this study looks to answer the research question on how does volatility in foreign exchange rates influence financial performance of agricultural sector in Kenya? The study was anchored the purchasing power parity (PPP) theory, international fisher effect theory and the flow oriented model. The study design adopted was the cross sectional as well as descriptive and secondary data was collected from KNBS and CMA reports. The result findings from trend analysis indicated that the agriculture sector has had instability and fluctuation in financial performance as determined by ROA. The study noted that inflationary pressure was relatively higher in comparison to interests’ rates across the entire period that the study focused on. From correlation analysis the study noted that foreign exchange rate volatility had positive relationship with financial performance. The control variables (interest and inflation) also had direct and significant interaction with ability of the firm to perform financially. Regression analysis was conducted value of adjusted R square was 0.606; which was interpreted to mean that 60.6% variability in the ability of the firm to perform is explained by changes in exchange rates. It was concluded that volatility in exchange rate and the ability of the firm to perform financially are positively and significantly related. It was recommended that entities in the agriculture sector need to ensure that proper strategies of managing exposure to foreign exchange risk are adopted for instance the use of derivatives.